Uncertainty Shocks, Asset Supply and Pricing Over the Business Cycle
63 Pages Posted: 6 May 2014 Last revised: 15 May 2023
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Uncertainty Shocks, Asset Supply and Pricing Over the Business Cycle
Uncertainty Shocks, Asset Supply and Pricing Over the Business Cycle
Date Written: May 2014
Abstract
This paper estimates a business cycle model with endogenous financial asset supply and ambiguity averse investors. Firms' shareholders choose not only production and investment, but also capital structure and payout policy subject to financial frictions. An increase in uncertainty about profits lowers stock prices and leads firms to substitute away from debt as well as reduce shareholder payout. This mechanism parsimoniously accounts for postwar comovement in investment, stock prices, leverage and payout, at both business cycle and medium term cycle frequencies. Ambiguity aversion permits a Markov-Switching VAR representation of the model, while preserving the effect of uncertainty shocks on the time variation in the equity premium.
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